Federal Subsidies = Higher State Taxes

A new study from economists Russell Sobel and George Crowley finds that federal subsidies to the states results in higher future state taxes. Specifically, the authors find that future state taxes increase by between 33 and 42 cents for every dollar the states receive in federal subsidies. A similar effect was found for federal and state aid to local governments.

This finding has important implications for state fiscal policy considering the recent rise in federal subsidies to state and local government:

Indeed, Sobel and Crowley’s study provides justification for the fears expressed by some governors that the recent influx of federal stimulus money could eventually lead to pressure on the states to raise taxes in order to maintain funding for programs boosted by federal aid.

As Sobel and Crowley note:

[S]pending programs create their own new political constituency, in that the government employees and private recipients whose incomes depend on the program, and their families, will use political pressure to fight against any discontinuation of the program…With more government funds comes additional fights over political resource allocations, and an expansion in the rent-seeking industry occurs…[F]ederal grants may result in an expansion in state lobbying activity that is successful in gaining influence over future state spending.

See this Cato essay on fiscal federalism for more on the problems with federal subsidies to state and local governments.